Bank & Finance

Capitalism

Capitalism, economic system in which private individuals and business firms carry on the production and exchange of goods and services through a complex network of prices and markets. Capitalism has certain key characteristics. First, basic production facilities- land and capital- are privately owned. Second, economic activity is organized and coordinated through the interaction of buyers and sellers (or producers) in markets. Third, owners of land and capital as well as the workers they employ are free to pursue their own self-interests in seeking maximum gain from the use of their resources and labor in production. Consumers are free to spend their incomes in ways that they believe will yield the greatest satisfaction. This principle reflects the idea that under capitalism, producers will be forced by competition to use their resources in ways that will best satisfy the wants of consumers. Fourth, a minimum of government supervision is required; if competition is present, economic activity will be self-regulating.

Beginnings of Modern Capitalism
Two 18th-century developments paved the way for the emergence of modern capitalism. The first was the appearance of the economists called physiocrats in France after 1750. Physiocracy is the term applied to a school of economic thought that suggested the existence of a natural order in economics, one that does not require direction from the state for people to be prosperous. According to the physiocrats, productive activities such as agriculture, fishing, and mining produce a surplus or net product. Other activities, such as manufacturing, do not produce new wealth but simply transform or circulate the output of the productive class.
The second development was the thought of British philosopher Adam Smith. He also tried to show the existence of an economic order that would function most efficiently if the state played a limited role, but unlike the physiocrats he did not believe that industry was unproductive. Rather, Smith saw in the division of labor and the extension of markets almost limitless possibilities for society to expand its wealth through manufacture and trade.

The Rise of Industrialization
The ideas of Smith and the physiocrats provided the ideological and intellectual background for the Industrial Revolution- the material side of the sweeping transformations in society and the world that characterized the 19th century. The industrialization process introduced mechanical power to replace human and animal power in the production of goods and services. Production became more specialized and concentrated in larger units, called factories. The application of mechanical power to production helped increase worker efficiency, which made goods abundant and cheap.

However, the development of industrial capitalism had serious human costs. The early days of the Industrial Revolution were marred by appalling conditions for large numbers of workers, especially in England. Abusive child labor, long working hours, and dangerous and unhealthy workplaces were common. These conditions led German political philosopher Karl Marx to produce his massive indictment of the capitalistic system, Das Kapital (3 volumes, 1867-1894). Marx's work struck at the fundamental principle of capitalism- private ownership of the means of production. Marx believed that land and capital should be owned by society as a whole and that the products of the system should be distributed according to need.

In the late 19th century, especially in the United States, the modern corporation began to emerge as the dominant form of business organization, and capitalism became the dominant economic system. The tendency toward corporate control of manufacturing led to many attempts to create combines, monopolies, or trusts that could control an entire industry. Eventually, the public outcry against such practices was great enough in the United States to lead the Congress of the United States to pass antitrust legislation. This legislation attempted to make the pursuit of monopoly by business illegal, trying to enforce at least a bare minimum of competition in industry and commerce.

20th-Century Capitalism
For most of the 20th century, capitalism has been buffeted by wars, revolution, and economic depressions. However, capitalist systems demonstrated remarkable abilities for survival and adaptability to change, including the use of government intervention to soften the impact of boom and bust cycles, periods of expansion and prosperity followed by economic depression and increased unemployment. World War I (1914-1918) brought revolution and a Marxist-based Communism to Russia. The war also spawned the Nazi system in Germany (see National Socialism), a mixture of capitalism and state socialism, brought together in a regime whose violence and expansionism eventually pushed the world into another major conflict, World War II (1939-1945). After the war, Communist economic systems took hold in China and Eastern Europe. The Western capitalist nations enjoyed economic growth and rising standards of living, although inflation and unemployment continued to be intermittent problems. As the Cold War came to an end in the 1980s, the former Soviet-bloc nations turned to capitalism (with mixed success at first). China was the only major power to retain a Marxist regime. Many of the developing nations, strongly influenced by Marxist ideas in the early postcolonial period, turned to a modified form of capitalism in their search for answers to economic problems.

Smith, Adam
Smith, Adam (1723-1790), British philosopher and economist, who conducted the first serious attempt to study the nature of capital and the historical development of industry and commerce among European nations. He was born in Kirkcaldy, Scotland. He developed a friendship with Scottish philosopher David Hume that contributed to his ethical and economic theories.
From 1766 to 1776, he wrote his treatise An Inquiry into the Nature and Causes of the Wealth of Nations (1776). This work represents the first serious attempt in the history of economic thought to separate the study of political economy from the related fields of political science, ethics, and jurisprudence. It includes a penetrating analysis of the processes in which economic wealth is produced and distributed and demonstrates that the fundamental sources of all income are rent, wages, and profits. Smith's central thesis is that capital is best used for the production and distribution of wealth under conditions of governmental noninterference and free trade. To illustrate this concept of minimum government control in commercial endeavors, Smith explained the principle of the "invisible hand" in which every individual is led, as if by an invisible hand, to achieve the best good for all. Therefore any interference with free competition by government is almost certain to be injurious.

Free-Market Economy
Free-Market Economy, economic system in which individuals, rather than government, make the majority of decisions regarding economic activities and transactions (see Capitalism). In a free-market economy, the government enters the economy only to provide public goods such as defense, law and order, and education, and to perform a regulatory role in certain situations.
Proponents of free-market economies believe that they provide a number of advantages. They see free-market economies as encouraging individual responsibility for decisions, and they believe that economic freedom is essential to political freedom. Many people believe that free markets are more efficient in economic terms because they provide incentives both to individuals to allocate resources, such as labor and capital, among the most productive uses, and to firms to produce goods and services that the public wants, using the most efficient means of production.

Free-market economies are also criticized. Opponents believe that a free-market economy cannot ensure basic social values, such as alleviating poverty, or that the income distribution that results from a free-market economy may not be equitable. A free-market economy may also permit the accumulation of vast wealth and powerful vested interests that could threaten the survival of political freedom.

Economics
Economics, social science concerned with the production, distribution, exchange, and consumption of goods and services. Economists focus on the way in which individuals, groups, business enterprises, and governments achieve economic objectives efficiently. Economics can be divided into two major fields. The first, microeconomics, explains how the interplay of supply and demand in competitive markets creates a multitude of individual prices, wage rates, profit margins, and rental changes. The second field, macroeconomics, deals with explanations of national income and employment.

History of Economic Thought
Economic issues have occupied people's minds since ancient times. Greek philosophers Aristotle and Plato wrote about problems of wealth, property, and trade. Both felt that to live by trade was undesirable. The Romans borrowed their economic ideas from the Greeks and showed the same contempt for trade. During the Middle Ages (5th century to 15th century), the Roman Catholic church condemned usury (the taking of interest for money loaned) and regarded commerce as inferior to agriculture.

The development of modern nationalism during the 16th century shifted economic attention to increasing the wealth and power of the various nation-states. The economic policy of the time was known as mercantilism. Mercantilists valued gold and silver because with these metals a ruler could hire and outfit mercenaries, thus increasing the country's power. Many European nations began colonizing other parts of the world and siphoning precious metals and raw materials from their colonies.
A school of thought known as physiocracy arose in France during the second half of the 18th century. The physiocrats believed that all wealth originates in agriculture; wealth is then distributed from farmers to other groups. The physiocrats promoted free trade and laissez-faire. British economist Adam Smith met the leading physiocrats and developed their doctrines in his writings.

As a coherent economic theory, classical economics starts with Smith, continues with British economists Thomas Robert Malthus and David Ricardo, and culminates with British economist John Stuart Mill. Classical economists agreed on several major principles. All believed in private property, free markets, and the benefits of competition. They shared Smith's suspicion of governmental involvement in the economy and his belief that the individual pursuit of private gain increased the public good. From Ricardo, classicists derived the notion of diminishing returns, which held that as more labor and capital were applied to land, a point was reached after which yields steadily diminished.

One debate was in regard to population growth. Malthus maintained that human population growth would eventually outstrip food production, leading to famine, war, epidemics, and plague. Mill believed that human population could rationally be limited. He also thought that government could play a role in the economy and favored worker ownership of factories. Mill thus represents a bridge between classical laissez-faire economics and an emerging welfare state.

German political philosopher Karl Marx provided the most important opposition to classical economics. Marx's historical studies convinced him that profit and other property income result from force and fraud inflicted by the strong on the weak. Thus, the central social conflict is between capitalists who own the means of production- factories and machines- and workers who possess nothing but their bare hands. Exploitation is measured by the capacity of capitalists to pay no more than subsistence wages to their employees and extract for themselves as profit the difference between these wages and the selling price of market commodities. Marx argued that the internal contradictions within capitalism- its social inequities- would eventually end its existence.

According to Marx, the crises of capitalism would manifest themselves in falling rates of profit, mounting hostility between workers and employers, and ever more severe depressions. Class warfare would lead to revolution and progress toward, first, socialism and, ultimately, communism. Once communism was achieved, the state would wither away, and each individual would be compensated according to need.
Classical economics proceeded from the assumption of scarcity of resources. Dating from the 1870s, neoclassicist economists shifted emphasis from limitations on supply to interpretations of consumer choice. Neoclassicists explained market prices according to the intensity of consumer preference for one more unit of a commodity. British economist Alfred Marshall explained demand by the principle of marginal utility, and supply by the rule of marginal productivity (the cost of producing the last item of a given quantity). In competitive markets, consumer preferences for low prices of goods and seller preferences for high prices settle on a mutually agreeable level. This same reconciliation between supply and demand occurs in markets for money and human labor. For example, in competitive labor markets, actual wages represent to the employer the value of the output, and to the employee the acceptable compensation for the work.

During the Great Depression of the 1930s, accepted strategies for reversing the depression failed, and fresh policies were urgently required. British economist John Maynard Keynes supplied them. In his work The General Theory of Employment, Interest, and Money (1936), he asserted that (1) neither high prices nor high wages explain persistent depression and mass unemployment, and (2) the explanation of these phenomena should be focused on aggregate demand- that is, the total spending of consumers, business investors, and governmental bodies. When aggregate demand is low, sales and jobs suffer; when it is high, all is well and prosperous. These ideas form the basis of contemporary macroeconomics. The national economy depends not on the actions of consumers, who are limited in the amounts that they can spend by the size of their incomes, but on business investors and governments, who invest in the economy. In a recession or depression, the proper thing to do is either to enlarge private investment or create public substitutes. This is done through easy credit or low interest rates, or more drastically by incurring deliberate budget deficits through public projects or subsidies to afflicted groups.
Economic Systems

The two major economic systems are the free-enterprise system and the Communist system. The major differences between these concern ownership of factories, farms, and other enterprises, and contrasting principles of pricing and income distribution. In free-enterprise societies, much of the gross national product (GNP) is directly generated by profit-making business enterprises, farmers, and private institutions. Prices are determined by markets, and income is not firmly established. In Communist economies, the state plans much of the price setting, and there is public ownership of factories, farms, and large retail establishments. However, all organized economic systems mix market activity and government intervention to some degree.
Falling somewhere between societies that emphasize either central planning or free enterprise are those that formally practice social democracy, or liberal socialism. For example, Sweden organizes the bulk of productive activity under private ownership but regulates this activity closely, intervenes to protect the jobs of workers, and redistributes substantial portions of profits and large individual incomes to low-income groups.

Free Trade
Free Trade, interchange of commodities across political frontiers without restrictions such as tariffs, quotas, or foreign exchange controls. This economic policy contrasts with protectionist policies that use such restrictions to protect or stimulate domestic industries.

The argument for free trade is in great part based on the ideas of 18th-century British economist Adam Smith, who asserted that each country should specialize in the production and export of goods in which it has an absolute advantage- that is, the goods that it can produce more cheaply than any of its trading partners. Another British economist, David Ricardo, extended that analysis to encompass the more general case of comparative advantage. Ricardo noted that even the nations that lack an absolute advantage in production of any commodity can gain from free trade if they concentrate on producing commodities in which they have the smallest disadvantage. This enables the nation to trade goods that are easiest to produce for goods that are more difficult to produce.  When nations practice the principle of comparative advantage, more goods are produced between the trading countries, and the wealth of both countries increases.

However, few countries have ever actually adopted a policy of free trade. One of the oldest arguments for protectionist policies is the so-called infant-industry argument. According to this theory, when foreign competition is reduced or eliminated by import barriers, domestic industries can develop rapidly. After their development is complete, they should be able to hold their own in competition with industries of other nations, and protection should no longer be required. In practice, however, protection frequently cannot be removed, because the domestic industries never develop sufficient competitive strength. Another argument for protection is the national defense argument, which seeks to avoid dependence on foreign sources for supplies of essential materials or finished products that might be denied in time of war.

When economies are booming and jobs seem secure, most people tend to support free trade. When recessions occur, many nations become more protectionist because of national interest and pressure from interest groups that are adversely affected by prolonged recessions. Since World War II ended in 1945, the leading trading nations have generally made a concerted effort to promote freer trade and to remove protection barriers. In 1948 the General Agreement on Tariffs and Trade (GATT) went into effect. GATT was a treaty and international trade organization that worked to reduce or eliminate tariffs and other barriers to trade. Membership in GATT increased steadily until 1995, when its activities were taken over by the World Trade Organization (WTO), an international organization that promotes free trade.

Laissez-Faire
Laissez-Faire, in economics, policy of domestic nonintervention by government in individual or industrial monetary affairs. The term is French for "let things alone." The doctrine, which arose in the late 18th century, favors capitalist self-interest, competition, and natural consumer preferences as forces leading to optimal prosperity and freedom. The principles of laissez-faire and free trade appealed strongly to the growing class of capitalists of the Industrial Revolution. Inevitably, with the tremendous growth of industry, laissez-faire policies led to abuses, especially in the use of child labor. Gradually, businesses combined to control production and prices for the benefit of their owners. Thus, competition- a basic tenet of the laissez-faire system- was eliminated. This trend toward monopolies led to calls for reform, and government controls were reasserted. Laissez-faire still exists today in the emphasis placed on the profit motive and on individual initiative in economic progress.

Asia-Pacific Economic Cooperation
Asia-Pacific Economic Cooperation (APEC), organization of 18 nations, bordering the Pacific Ocean, that is dedicated to promoting regional economic integration and free trade, as well as global free trade. APEC was founded in 1989 at the prompting of the Australian government. As of 1996, its members included Australia, Brunei, Canada, Chile, China, Hong Kong, Indonesia, Japan, Malaysia, Mexico, New Zealand, Papua New Guinea, the Philippines, Singapore, South Korea, Taiwan, Thailand, and the United States. Together, the APEC members account for more than 50 percent of the world's economic production.